Dhuraivel Gunasekaran
Let’s say you have to choose between two large-cap funds. One is a large-sized scheme that has given 2.3 percent returns over the past three years. The other is one of an old scheme and has given 5.7 percent in the same period. Aren’t you most likely to go for the second scheme?
Dig a little deeper. The first scheme has actually given 14.8 percent returns if you look at a series of three-year returns over the past seven-year period. During this same time frame, the second gave 12 percent returns. The first scheme looks attractive now, doesn’t it?
One of the first things investors look for when buying a mutual fund is its past return. But fund houses almost always disclose returns between two points in time. These are commonly referred to as point-to-point returns, as mentioned in the first instance above.
Financial advisors and savvy investors often look at ‘rolling returns’ that gives a clearer picture of how the fund has performed in the past. There is a third way of measuring performance too, especially if you keep investing in a fund repeatedly through a systematic investment plan. This method is called internal rate of return. Let’s stick to rolling returns for now.
What are rolling returns?
Simply put, rolling returns show you how a fund has performed consistently over a long period of time. Ordinarily, a three-year or a five-year return, for instance, gives you the return a fund has earned in a specific period. But that is just one period. Has it consistently given good returns over multiple three-year and five-year periods, for instance?
Here’s where rolling returns help. If you want to check how a scheme has performed over the past five-year periods, you can take a series of one-year returns over the last five years. You have to calculate one-year return for the fund on each day of the period selected. You will get a series of one-year returns as on each date for the entire five years.
You can start calculating the one-year return from those NAVs of the date between say 10-Oct-2020 and 10-Oct-2019. Then you move down one day and calculate the return for the period between 9-Oct-2020 and 9-Oct-2019. You have to keep rolling down one day and do this exercise for the entire five-year period. Eventually, you will get the series of one-year returns with around 1,000 data points (assuming the stock market is trading for 250 days in a year). The average of these returns is the rolling one-year return, rolled daily over five years.
Point-to-point returns do not show consistency
Deepak Jasani, Head, Retail Research, HDFC securities, says “trailing returns or point to point returns, which are widely used by fund houses and investors to judge the performance of schemes, are dependent on two price points and they are subject to start-point and end-point bias.”
Point-to-point returns don’t tell you anything about what happened in the period between these two dates. For instance, UTI Mid-cap fund has given 9.7 per cent returns this year, as on October 13, 2020. But, it also fell sharply by 30 per cent in March 2020, in line with the other equity funds, due to the COVID-19 pandemic, before it recovered as markets picked up. The point-to-point return does not capture that.
Second, if the market was at the bottom at the ‘start date’ and the ‘to date’ is selected when the indices are up, then the return will be positive. On the other hand, if market was bullish at the time of the ‘from date,’ but struggling when the ‘to date’ is selected, then the return will be negative.
In reality, investors enter and exit mutual funds at all times. Point-to-point returns do not provide you a comprehensive picture of the fund’s performance across all time frames. In simple words, it doesn’t show whether or not your fund has been consistent.
Why point-to-point returns are better
Since the rolling return is calculated for a given period, which covers various market cycles, it provides you a better picture of how a fund delivered in different market conditions.
“Rolling return gives a clear record of historical returns through which one can get an average historical performance of the fund at periodical entry points. From this, one can get an idea of future expected returns if the market conditions are not too different and investment horizon is similar. Based on the investment horizon, you can calculate rolling returns. For instance, if one has an investment horizon of three years, he can take the data points for three years back plus three years more so that three-year return is available from the first day of the last three-year period, Jasani adds.
Sambath Kumar, Head of sales at Spark Alternative Asset Advisors says “As far as equity funds are concerned, investors can consider a period of 5-6 years for calculating the rolling return that covers at least one full market cycle, including bull, bear and sideways markets. For debt funds, a 4-5-year period seems sufficient covering at least one rising and falling interest rate scenarios.”
Problem is that such rolling return data are not publicly available.
Procuring raw data for schemes and benchmarks, and computing rolling return for all the schemes in a category on your own is an extremely a tedious process. However, you can ask your financial planner to provide rolling return data.
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